Archives For IP

On November 10, at the University of Southern California Law School, Assistant Attorney General for Antitrust Makan Delrahim delivered an extremely important policy address on the antitrust treatment of standard setting organizations (SSOs). Delrahim’s remarks outlined a dramatic shift in the Antitrust Division’s approach to controversies concerning the licensing of standard essential patents (SEPs, patents that “read on” SSO technical standards) that are often subject to “fair, reasonable, and non-discriminatory” (FRAND) licensing obligations imposed by SSOs. In particular, while Delrahim noted the theoretical concerns of possible “holdups” by SEP holders (when SEP holders threaten to delay licensing until their royalty demands are met), he cogently explained why the problem of “holdouts” by implementers of SEP technologies (when implementers threaten to under-invest in the implementation of a standard, or threaten not to take a license at all, until their royalty demands are met) is a far more serious antitrust concern. More generally, Delrahim stressed the centrality of patents as property rights, and the need for enforcers not to interfere with the legitimate unilateral exploitation of those rights (whether through licensing, refusals to license, or the filing of injunctive actions). Underlying Delrahim’s commentary is the understanding that innovation is vitally important to the American economy, and the concern that antitrust enforcers’ efforts in recent years have threatened to undermine innovation by inappropriately interfering in free market licensing negotiations between patentees and licensees.

Important “takeaways” from Delrahim’s speech (with key quotations) are set forth below.

Thumb on the scale in favor of implementers: “In particular, I worry that we as enforcers have strayed too far in the direction of accommodating the concerns of technology implementers who participate in standard setting bodies, and perhaps risk undermining incentives for IP creators, who are entitled to an appropriate reward for developing break-through technologies.”

Striking the right balance through market forces (as opposed to government-issued best practices): “The dueling interests of innovators and implementers always are in tension, and the tension is resolved through the free market, typically in the form of freely negotiated licensing agreements for royalties or reciprocal licenses.”

Holdup as theoretical concern with no evidence that it’s a systemic or widespread problem: He praises Professor Carl Shapiro for his theoretical model of holdup, but stresses that “many of the proposed [antitrust] ‘solutions’ to the hold-up problem are often anathema to the policies underlying the intellectual property system envisioned by our forefathers.”

Rejects prior position that antitrust is only concerned with the patent-holder side of the holdup equation, stating that he’s more concerned with holdout given the nature of investments: “Too often lost in the debate over the hold-up problem is recognition of a more serious risk: the hold-out problem. . . . I view the collective hold-out problem as a more serious impediment to innovation. Here is why: most importantly, the hold-up and hold-out problems are not symmetric. What do I mean by that? It is important to recognize that innovators make an investment before they know whether that investment will ever pay off. If the implementers hold out, the innovator has no recourse, even if the innovation is successful. In contrast, the implementer has some buffer against the risk of hold-up because at least some of its investments occur after royalty rates for new technology could have been determined. Because this asymmetry exists, under-investment by the innovator should be of greater concern than under-investment by the implementer.”

What’s at stake: “Every incremental shift in bargaining leverage toward implementers of new technologies acting in concert can undermine incentives to innovate. I therefore view policy proposals with a one-sided focus on the hold-up issue with great skepticism because they can pose a serious threat to the innovative process.”

Breach of FRAND as primarily a contract or fraud, not antitrust issue: “There is a growing trend supporting what I would view as a misuse of antitrust or competition law, purportedly motivated by the fear of so-called patent hold-up, to police private commitments that IP holders make in order to be considered for inclusion in a standard. This trend is troublesome. If a patent holder violates its commitments to an SSO, the first and best line of defense, I submit, is the SSO itself and its participants. . . . If a patent holder is alleged to have violated a commitment to a standard setting organization, that action may have some impact on competition. But, I respectfully submit, that does not mean the heavy hand of antitrust necessarily is the appropriate remedy for the would-be licensee—or the enforcement agency. There are perfectly adequate and more appropriate common law and statutory remedies available to the SSO or its members.”

Recommends that unilateral refusals to license should be per se lawful: “The enforcement of valid patent rights should not be a violation of antitrust law. A patent holder cannot violate the antitrust laws by properly exercising the rights patents confer, such as seeking an injunction or refusing to license such a patent. Set aside whether taking these actions might violate the common law. Under the antitrust laws, I humbly submit that a unilateral refusal to license a valid patent should be per se legal. Indeed, just this Monday, Chief Judge Diane Wood, a former Deputy Assistant Attorney General at the Antitrust Division, stated that “[e]ven monopolists are almost never required to assist their competitors.”

Intent to investigate buyers’ cartel behavior in SSOs: “The prospect of hold-out offers implementers a crucial bargaining chip. Unlike the unilateral hold-up problem, implementers can impose this leverage before they make significant investments in new technology. . . . The Antitrust Division will carefully scrutinize what appears to be cartel-like anticompetitive behavior among SSO participants, either on the innovator or implementer side. The old notion that ‘openness’ alone is sufficient to guard against cartel-like behavior in SSOs may be outdated, given the evolution of SSOs beyond strictly objective technical endeavors. . . . I likewise urge SSOs to be proactive in evaluating their own rules, both at the inception of the organization, and routinely thereafter. In fact, SSOs would be well advised to implement and maintain internal antitrust compliance programs and regularly assess whether their rules, or the application of those rules, are or may become anticompetitive.”

Basing royalties on the “smallest salable component” as a requirement by a concerted agreement of implementers is a possible antitrust violation: “If an SSO pegs its definition of “reasonable” royalties to a single Georgia-Pacific factor that heavily favors either implementers or innovators, then the process that led to such a rule deserves close antitrust scrutiny. While the so-called ‘smallest salable component’ rule may be a useful tool among many in determining patent infringement damages for multi-component products, its use as a requirement by a concerted agreement of implementers as the exclusive determinant of patent royalties may very well warrant antitrust scrutiny.”

Right to Injunctive Relief and holdout incentives: “Patents are a form of property, and the right to exclude is one of the most fundamental bargaining rights a property owner possesses. Rules that deprive a patent holder from exercising this right—whether imposed by an SSO or by a court—undermine the incentive to innovate and worsen the problem of hold-out. After all, without the threat of an injunction, the implementer can proceed to infringe without a license, knowing that it is only on the hook only for reasonable royalties.”

Seeking or Enforcing Injunctive Relief Generally a Contract Not Antitrust Issue: “It is just as important to recognize that a violation by a patent holder of an SSO rule that restricts a patent-holder’s right to seek injunctive relief should be appropriately the subject of a contract or fraud action, and rarely if ever should be an antitrust violation.”

FRAND is Not a Compulsory Licensing Scheme: “We should not transform commitments to license on FRAND terms into a compulsory licensing scheme. Indeed, we have had strong policies against compulsory licensing, which effectively devalues intellectual property rights, including in most of our trade agreements, such as the TRIPS agreement of the WTO. If an SSO requires innovators to submit to such a scheme as a condition for inclusion in a standard, we should view the SSO’s rule and the process leading to it with suspicion, and certainly not condemn the use of such injunctive relief as an antitrust violation where a contract remedy is perfectly adequate.”

In her distinguished tenure as a Commissioner and as Acting Chairman of the FTC, Maureen Ohlhausen has done an outstanding job in explaining the tie between robust patent protection and economic growth and innovation (see, for example, her Harvard Journal of Law and Technology article, here). Her latest public pronouncement on this topic, an October 13 speech entitled “Strong Patent Rights, Strong Economy,” also makes a highly valuable contribution to the patent policy debate. Ohlhausen’s speech centers on two key points: “First, strong patent rights are crucial to economic success. And, second, economically grounded analysis will reveal the right path through thickets of IP [intellectual property] skepticism.” Ohlhausen concludes with a reaffirmation of the importance of having the United States lead by example on the world stage in defending strong patent rights:

Patents have been at the heart of US innovation since the founding of our country, and respect for patent rights is fundamental to advance innovation. The United States is more technologically innovative than any other country in the world. This reality reflects, in part, the property rights that the United States government grants to inventors. Still, foreign counterparts take or allow the taking of American proprietary technologies without due payment. For example, emerging competition regimes view “unfairly high royalties” as illegal under antitrust law. The FTC’s recent policy work offers an important counterweight to this approach, illustrating the important role that patents play in promoting innovation and benefiting consumers.

In closing, while we may live in an age of patent skepticism, there is hope. Criticism of IP rights frequently does not hold up upon closer examination. Rather, empirical research favors the close tie between strong IP rights and R&D. This is not to say that changes to the patent system are always unwarranted. Rather, the key to addressing the U.S. patent system lies in incremental adjustment where necessary based on a firm empirical foundation. The U.S. economy stands as a shining reminder of everything that American innovation policy has achieved – and intellectual property rights, and patents, are the important cornerstones of those achievements.

Ohlhausen’s remarks are, as always, thoughtful and well worth studying.

Nicolas Petitis Professor of Law at the University of Liege (Belgium) and Research Professor at the University of South Australia (UniSA)

This symposium offers a good opportunity to look again into the complex relation between concentration and innovation in antitrust policy. Whilst the details of the EC decision in Dow/Dupont remain unknown, the press release suggests that the issue of “incentives to innovate” was central to the review. Contrary to what had leaked in the antitrust press, the decision has apparently backed off from the introduction of a new “model”, and instead followed a more cautious approach. After a quick reminder of the conventional “appropriability v cannibalization” framework that drives merger analysis in innovation markets (1), I make two sets of hopefully innovative remarks on appropriability and IP rights (2) and on cannibalization in the ag-biotech sector (3).

Appropriability versus cannibalization

Antitrust economics 101 teach that mergers affect innovation incentives in two polar ways. A merger may increase innovation incentives. This occurs when the increment in power over price or output achieved through merger enhances the appropriability of the social returns to R&D. The appropriability effect of mergers is often tied to Joseph Schumpeter, who observed that the use of “protecting devices” for past investments like patent protection or trade secrecy constituted a “normal elemen[t] of rational management”. The appropriability effect can in principle be observed at firm – specific incentives – and industry – general incentives – levels, because actual or potential competitors can also use the M&A market to appropriate the payoffs of R&D investments.

But a merger may decrease innovation incentives. This happens when the increased industry position achieved through merger discourages the introduction of new products, processes or services. This is because an invention will cannibalize the merged entity profits in proportions larger as would be the case in a more competitive market structure. This idea is often tied to Kenneth Arrow who famously observed that a “preinvention monopoly power acts as a strongdisincentive to further innovation”.

Schumpeter’s appropriability hypothesis and Arrow’s cannibalization theory continue to drive much of the discussion on concentration and innovation in antitrust economics. True, many efforts have been made to overcome, reconcile or bypass both views of the world. Recent studies by Carl Shapiro or Jon Baker are worth mentioning. But Schumpeter and Arrow remain sticky references in any discussion of the issue. Perhaps more than anything, the persistence of their ideas denotes that both touched a bottom point when they made their seminal contribution, laying down two systems of belief on the workings of innovation-driven markets.

Now beyond the theory, the appropriability v cannibalization gravitational models provide from the outset an appealing framework for the examination of mergers in R&D driven industries in general. From an operational perspective, the antitrust agency will attempt to understand if the transaction increases appropriability – which leans in favour of clearance – or cannibalization – which leans in favour of remediation. At the same time, however, the downside of the appropriability v cannibalization framework (and of any framework more generally) may be to oversimplify our understanding of complex phenomena. This, in turn, prompts two important observations on each branch of the framework.

Appropriability and IP rights

Any antitrust agency committed to promoting competition and innovation should consider mergers in light of the degree of appropriability afforded by existing protecting devices (essentially contracts and entitlements). This is where Intellectual Property (“IP”) rights become relevant to the discussion. In an industry with strong IP rights, the merging parties (and its rivals) may be able to appropriate the social returns to R&D without further corporate concentration. Put differently, the stronger the IP rights, the lower the incremental contribution of a merger transaction to innovation, and the higher the case for remediation.

This latter proposition, however, rests on a heavy assumption: that IP rights confer perfect appropriability. The point is, however, far from obvious. Most of us know that – and our antitrust agencies’ misgivings with other sectors confirm it – IP rights are probabilistic in nature. There is (i) no certainty that R&D investments will lead to commercially successful applications; (ii) no guarantee that IP rights will resist to invalidity proceedings in court; (iii) little safety to competition by other product applications which do not practice the IP but provide substitute functionality; and (iv) no inevitability that the environmental, toxicological and regulatory authorization rights that (often) accompany IP rights will not be cancelled when legal requirements change. Arrow himself called for caution, noting that “Patent laws would have to be unimaginably complex and subtle to permit [such] appropriation on a large scale”. A thorough inquiry into the specific industry-strength of IP rights that goes beyond patent data and statistics thus constitutes a necessary step in merger review.

But it is not a sufficient one. The proposition that strong IP rights provide appropriability is essentially valid if the observed pre-merger market situation is one where several IP owners compete on differentiated products and as a result wield a degree of market power. In contrast, the proposition is essentially invalid if the observed pre-merger market situation leans more towards the competitive equilibrium and IP owners compete at prices closer to costs. In both variants, the agency should thus look carefully at the level and evolution of prices and costs, including R&D ones, in the pre-merger industry. Moreover, in the second variant, the agency ought to consider as a favourable appropriability factor any increase of the merging entity’s power over price, but also any improvement of its power over cost. By this, I have in mind efficiency benefits, which can arise as the result of economies of scale (in manufacturing but also in R&D), but also when the transaction combines complementary technological and marketing assets. In Dow/Dupont, no efficiency argument has apparently been made by the parties, so it is difficult to understand if and how such issues have played a role in the Commission’s assessment.

Cannibalization, technological change, and drastic innovation

Arrow’s cannibalization theory – namely that a pre-invention monopoly acts as a strong disincentive to further innovation – fails to capture that successful inventions create new technology frontiers, and with them entirely novel needs that even a monopolist has an incentive to serve. This can be understood with an example taken from the ag-biotech field. It is undisputed that progress in crop protection science has led to an expanding range of resistant insects, weeds, and pathogens. This, in turn, is one (if not the main) key drivers of ag-tech research. In a 2017 paper published in Pest Management Science, Sparks and Lorsbach observe that:

resistance to agrochemicals is an ongoing driver for the development of new chemical control options, along with an increased emphasis on resistance management and how these new tools can fit into resistance management programs. Because resistance is such a key driver for the development of new agrochemicals, a highly prized attribute for a new agrochemical is a new MoA [method of action] that is ideally a new molecular target either in an existing target site (e.g., an unexploited binding site in the voltage-gated sodium channel), or new/under-utilized target site such as calcium channels.

This, and other factors, leads them to conclude that:

even with fewer companies overall involved in agrochemical discovery, innovation continues, as demonstrated by the continued introduction of new classes of agrochemicals with new MoAs.

Sparks, Hahn, and Garizi make a similar point. They stress in particular that the discovery of natural products (NPs) which are the “output of nature’s chemical laboratory” is today a main driver of crop protection research. According to them:

NPs provide very significant value in identifying new MoAs, with 60% of all agrochemical MoAs being, or could have been, defined by a NP. This information again points to the importance of NPs in agrochemical discovery, since new MoAs remain a top priority for new agrochemicals.

More generally, the point is not that Arrow’s cannibalization theory is wrong. Arrow’s work convincingly explains monopolists’ low incentives to invest in substitute invention. Instead, the point is that Arrow’s cannibalization theory is narrower than often assumed in the antitrust policy literature. Admittedly, Arrow’s cannibalization theory is relevant in industries primarily driven by a process of cumulative innovation. But it is much less helpful to understand the incentives of a monopolist in industries subject to technological change. As a result of this, the first question that should guide an antitrust agency investigation is empirical in nature: is the industry under consideration one driven by cumulative innovation, or one where technology disruption, shocks, and serendipity incentivize drastic innovation?

Note that exogenous factors beyond technological frontiers also promote drastic innovation. This point ought not to be overlooked. A sizeable amount of the specialist scientific literature stresses the powerful innovation incentives created by changing dietary habits, new diseases (e.g. the Zika virus), global population growth, and environmental challenges like climate change and weather extremes. In 2015, Jeschke noted:

In spite of the significant consolidation of the agrochemical companies, modern agricultural chemistry is vital and will have the opportunity to shape the future of agriculture by continuing to deliver further innovative integrated solutions.

Words of wisdom caution for antitrust agencies tasked with the complex mission of reviewing mergers in the ag-biotech industry?

Truth on the Market is delighted to welcome our newest blogger, Neil Turkewitz. Neil is the newly minted Senior Policy Counsel at the International Center for Law & Economics (so we welcome him to ICLE, as well!).

Prior to joining ICLE, Neil spent 30 years at the Recording Industry Association of America (RIAA), most recently as Executive Vice President, International.

Neil has spent most of his career working to expand economic opportunities for the music industry through modernization of copyright legislation and effective enforcement in global markets. He has worked closely with creative communities around the globe, with the US and foreign governments, and with international organizations (including WIPO and the WTO), to promote legal and enforcement reforms to respond to evolving technology, and to promote a balanced approach to digital trade and Internet governance premised upon the importance of regulatory coherence, elimination of inefficient barriers to global communications, and respect for Internet freedom and the rule of law.